Time and again, we deal with and hear of instances where software development businesses have fallen short of the tax reliefs they are entitled to because of a lack of understanding.
As R&D tax specialists, we want to ensure software developers are in the best possible position to leverage the benefits from the incentives that are available to them, which have the potential to reduce costs, maximise profitability and ultimately, help stimulate growth.
We’ve dispelled some of the common myths we believe are regularly preventing legitimate claims from across the software development industry ever coming to fruition.
1. ‘We don’t have a claim’
This is a common misconception that is fuelled by several factors, one of which is that there is no simple, one-size-fits-all checklist in place to determine what qualifies for relief.
Added to this is the fact that many organisations do not view their R&D as R&D because it forms part of their day-to-day work. For example, many software development firms believe that they are not eligible for relief as ‘R&D’ tends to conjure up images of test tubes and white lab coats.
However, by taking the time to look into their activity in detail alongside the R&D legislation and guidelines on the definition of R&D, many software development firms actually discover that much of the work they are carrying out is eligible for tax relief.
The software industry is extremely R&D intensive. Due to the fast-paced nature of software development, the goal posts are constantly moving and companies need to be consistently innovative to stay in the game.
Software development is by no means restricted to software companies; it covers every single industry sector, from retailers upgrading tills and manufacturers improving warehouse management systems, to F1 teams gathering and analysing vast amounts of data and investment managers developing ever more complex algorithms for high frequency trading. Any company that has attempted to upgrade its back office IT systems will have probably encountered issues requiring some level of bespoke development.
One of the biggest challenges for software development claims lies in how to present supporting information to HMRC in order to secure the relief. HMRC does not employ software specialists, therefore companies must present their projects in such a way as to convince, without creating confusion.
2. ‘The system is too complicated for us to claim’
Of the £1.1billion relief awarded in 2011, the proportion claimed by large companies accounted for 67%. This is despite the fact there were far few claims overall and the rate of relief for large companies is far less generous than for SMEs. This picture clearly illustrates that the relief given out to date, is heavily skewed to larger claimants.
Many smaller companies feel overwhelmed by the complex definition of R&D, which underpins the relief, and do not have the resources available to get up to speed on this specialist area of taxation.
It can be a challenge to get R&D tax relief on to the boardroom agenda, in particular when faced with the misconception that the industry ‘doesn’t do R&D’ and the uncertainty over the eligibility of trial activities.
As it is a tax relief, the rules must be written into tax legislation that can make them less accessible to smaller businesses however, help is at hand for software development firms. HMRC publishes its own guidance manual on the subject of claiming as well as dedicating a whole section of its website to this topic.
In addition, there are seven specialist units within HMRC whose primary focus is to provide R&D claims advice. Further assistance can also be found in the form of specialist advisors, who operate within this field and can help software development companies to scope out their claim potential and apply for relief on a no win, no fee basis.
3. ‘Tax credits are invisible’
R&D tax relief was introduced to encourage UK companies to increase the amount of R&D activity they undertake. However, the clue is in the name, and it may well remain hidden in the tax line of financial statements. This makes it largely ‘invisible’ to R&D decision-makers. In addition, until April 2013, only SMEs could recognise an immediate benefit from their claim if they were loss making for tax purposes, by converting the relief to a payable credit. Under the large company relief, all loss makers got was an increased pool of losses.
The Government has moved to address these issues with the introduction of R&D Expenditure Credits (R&DEC) in April this year. As a taxable flat-rate credit, it has been positioned as having enough hallmarks of a grant, meaning it can be accounted for ‘above the line’ and is more visible to those with the power to increase R&D investment. For large software development companies, this means that the R&DEC can be offset directly against operating costs, a welcome profitability boost at a time when margins are becoming ever tighter. If there is no tax liability to offset the credit against, HMRC will pay it in cash to the claimant, so it could also provide a cash boost for claimants.
The R&DEC is available to large companies and certain SMEs that are restricted from the SME R&D tax relief regime due to their circumstances. Most SMEs can already access a payable cash credit for their R&D expenditure in certain circumstances. However, where an SME carries out R&D on behalf of a customer, or has received subsidies or grants to cover R&D expenditure, the SME is locked out of the more generous SME rates and access to the payable credit. These companies may claim under the large company scheme, but many have, in the past, chosen not to claim relief at all. The introduction of the R&DEC should be good news for many of these companies, who will be able to claim a cash credit for the first time.
4. ‘Tax relief involves aggressive tax planning’
This is an extremely common misconception that is often raised in relation to R&D tax relief. The debate has also been further intensified with global news headlines involving corporate tax avoidance and evasion and the gap between what is legal and what is morally acceptable, continuing to be a hot topic of discussion.
In reality, many software development businesses do not realise there is a huge distinction between tax planning, where a structure or transaction is developed that results in a favourable tax position, and tax incentives such as R&D tax relief - a scheme designed by the Government to provide a favourable tax position.
Software development companies do need to make sure they meet the relevant criteria and follow the rules, but if their claim is robust, they will be able to claim the relief they are entitled to.
5. ‘The relief is going to be scrapped’
This may have been a legitimate concern a few years ago, with opposition politicians making no secret of the fact they did not support the R&D incentives in place.
However, it would appear the incentives are not only here to stay, but have improved in generosity in recent years. The rate of relief for SMEs has increased from 175% to 225% in the past three years alone. The introduction of the R&D Expenditure Credit for large companies also represents a significant step forward as it is the first time these organisations can obtain a cash credit for their R&D.
Looking ahead, while we cannot predict who will win the next General Election, the precedent has been set that the UK wants to attract, encourage and retain R&D companies. To do this, the incentives must remain globally competitive.
Jennifer Tragner is R&D Tax Director at leading research and development tax specialists, Alma Consulting Group. More information about Alma can be found at www.almacg.co.uk
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